Non-banking financial company Housing Development Finance Corporation (HDFC), which on July 12 opened subscriptions for its masala bonds – the first by a private Indian firm – is reported to have received a robust initial response. The company is learnt to have received bids for nearly three times its offer.

At a time when the sentiment around Britain’s exit from the European Union – popularly referred to as Brexit – presents an opportunity to tap foreign investments, other private Indian firms like Adani Transmission and public undertakings like National Highways Authority of India (NHAI), Rural Electrification Corporation and Power Finance Corporation are also said to be planning to issue masala bonds.

What are masala bonds?

Masala bonds are rupee-denominated bonds that Indian entities use to raise funds from foreign markets. Though they are rupee-denominated, they are, in fact, foreign currency bonds; the difference is that masala bonds are structured in a way that foreign investors will be able to reap the benefits of investing in rupee-denominated Indian bonds.

The International Finance Corporation (IFC), an arm of the World Bank, had issued masala bonds in 2014 to raise Rs 1,000 crore for infrastructure projects in India. But no private Indian firm had issued masala bonds before HDFC. IFC had then called these rupee-denominated bonds masala bonds to give them a local flavour. This is not unusual: Offshore bonds denominated in local currencies in China, for example, are called Dim-sum bonds; those in Japan are known as Samurai bonds.

How will its masala bonds help HDFC?

HDFC’s masala bonds will help the company borrow money from a diverse set of investors across the world. At the same time, investors will be able to judge HDFC’s masala bonds on their own merits; nationality does not restrict their choices. Amid the news of the proposed Brexit, investors will also be able to spread their risk by investing in a diverse set of instruments. HDFC will not be exposed to risks related to issuing bonds denominated in say, the US dollar, but investors will bear the burden of currency-related risks. This is one reason why foreign investors had earlier demanded that interest rates on masala bonds be higher than those in Indian markets. But when the rupee started performing better, investors were willing to lower their expectations.

What is the significance of masala bonds for India?

India’s financial markets are not well developed because the regulatory framework places too many constraints on banks and financial institutions. Harvard economist Edward Glaeser once said that if a government cannot provide clean water, it should not try to regulate vast swaths of the economy. This is very true of financial market regulations in India. This leaves Indian firms with limited access to funds. Without deep, liquid markets for corporate bonds, Indian firms are not likely to have enough access to funds. If Indian firms cannot raise funds from investors abroad, it will be difficult to have flourishing, liquid markets for corporate bonds.

How will India’s real estate market benefit from masala bonds?

In 2015, the Reserve Bank of India (RBI) had decided to allow Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) to issue masala bonds.

Indian real estate markets will find masala bonds an important debt instrument, because otherwise REITs, InvITs and other firms will be largely dependent on banks and equity markets. When firms are free to raise funds from foreign debt markets, more avenues of funding will open up. Real estate and infrastructure projects are among the most cash-strapped. Also, long-term projects are heavily dependent on changes in policies of governments and urban local authorities. There is low demand for residential projects in many Indian cities because infrastructure and real estate projects take very long. This is less likely when firms are free to benefit from a wider set of financial instruments.